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Defense Firms Await Cuts but Offer Premium Yields

Stallard's research predicted that in the worst-case scenario defense primes could see earnings per share drop on average about 10%.

A lot of this would hinge on bipartisan action on Capitol Hill shortly before the end of the year.

Analysts have argued that the Department of Defense may need more time to hash out a reasonable plan to cut its budget. The range of time necessary to reach a better budget cut agreement could be as little as a month or two or as long as a year, said Oppenheimer's Reiner.

Partisanship has characterized much of the past two years in Washington, and politics grew especially heated last summer when Democrats and Republicans -- along with a split of consensus between Tea Party members and establishment GOP members -- extended a debt-ceiling debate that roiled markets and concluded with a Standard & Poor's downgrade of the U.S. credit rating.

A single party sweep of the House and Senate could provide more concrete expectations for defense cuts, but that scenario appears increasingly unlikely. Divided chamber leadership would make bipartisan agreements critical to avoid one of the aforementioned extreme scenarios.

"At the end of the day it still takes compromise," said one person familiar with the defense sector. "I'm not sure that there is a big solution out there, i.e. massive entitlement spending reform that opens up the door to the structural deficit going away."

Near-term effects from cuts for the defense companies would be felt in their services like equipment repairs and maintenance.

Though it's almost certain defense cuts loom -- whether from sequestration or specific action by Congress in some agreement with the Department of Defense -- investors may find more solace with a gradual decline in defense business dictated by specific spending cuts than they would trust in the volatile global economy.

William Loomis, a managing director at Stifel Nicolaus, said the longer-term risks for defense would likely be a lack of growth. He added that the dividends wouldn't be cut for at least three or four years, if at all.

"Another key difference between this period and what we saw in the downturn in the 1970s and the downturn in the late 80s is that the defense companies I mention are executing quite well -- a key part of that reason is that they're not trying to diversify into completely unrelated businesses," said Loomis.

Loomis said those disaster stories witnessed companies like Lockheed and Northrop Grumman back then get into appliances and construction.

That won't be the case this time around.

-- Written by Joe Deaux in New York.

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